January 5, 2000

BIR RULING NO. 006-00

34 (B) 000-00 006-2000
Philippine National Bank
PNB Financial Center
Roxas Boulevard, Metro Manila
Attention: Atty. Julian B. Soriano
Gentlemen :
This refers to your letter dated November 6, 1998 stating that with reference to Section 34(B) of the
Tax Reform Act of 1997 disallowing as a deduction a portion of Bank's interest expense representing
41% of interest income subjected to final tax, you are of the understanding that the said provision was
introduced to mitigate the effects of the so-called tax arbitrage scheme where taxpayers save
approximately 14% on taxes by placing their excess funds in government securities and pay only a 20%
tax on the interest derived therefrom instead of the 34% corporate tax that will be imposed had such
excess been used for other income-generating activities not subject to final tax; that as a result of the
Codal provision, taxpayers will no longer enjoy the tax benefit/savings that otherwise may be derived
from the tax arbitrage; that the 12-year treasury bonds were given by the Government as payment for
its liabilities to PNB as embodied in the Memorandum of Agreement (MOA) dated August 14, 1995
executed between the National Government, as represented by the Department of Finance, and PNB;
and that PNB, therefore, has not engaged in a tax arbitrage scheme.
Based on the foregoing representations and documents submitted, you are now requesting for a ruling
that interest income derived by PNB from the treasury bonds be excluded in the determination of the
interest expense not allowable as deduction from gross income.
In reply, please be informed that pursuant to Section 34(B) of the Tax Code of 1997, although as a
general rule, the amount of interest expense paid or incurred by a taxpayer within a taxable year on
indebtedness in connection with his trade, business or exercise of profession shall be allowed as a
deduction from his gross income, the said interest expense, however, shall be reduced if the taxpayer
has derived certain interest income which had been subjected to final withholding tax. The said
reduction shall be equal to the following percentages of the interest income earned depending on the
year when the interest income was earned, viz:
Forty-one percent (41%) beginning January 1, 1998;
Thirty-nine percent (39%) beginning January 1, 1999; and
Thirty-eight percent (38%) beginning January 1, 2000 and thereafter.
This limitation shall apply regardless of whether or not a tax arbitrage scheme was entered into by the
taxpayer or regardless of the date of the interest-bearing loan and the date when the investment was
made, for as long as, during the taxable year, there is an interest expense incurred on one side and an
interest income earned on the other side, which interest income had been subjected to final withholding
tax.

Accordingly, your request that your interest income derived from the said treasury bonds be excluded
in the determination of the interest expense not allowable as deduction from gross income is hereby
denied pursuant to Section 34(B) of the Tax Code of 1997.
Very truly yours,
(SGD.) BEETHOVEN L. RUALO
Commissioner of Internal Revenue